From 1955 until the late 1980s, Vietnam employed a
neo-Stalinist approach to economic development.The central government devised a plan to encourage economic
growth, with the primary objectives of strengthening modern industry and
capital capacity.The plan was known as
the DRV Model, named after the Democratic Republic of Vietnam.The DRV Model’s goal of ‘producing the
factors of production’ led to aggregated shortages, chronic fiscal deficits,
and large dependency on imports to complement the established capital. (Fforde
and Paine, 1987, p.75)The policy decisions
made by the central government, especially with respect to state owned
industries, and the ineffectiveness of the political leadership from 1955 to
1975 caused the major obstacles Vietnam has faced in its movement toward
globalization, and these prevented economic growth from being maximized.

VIETNAM:1955 – 1975

The central government’s adoption of the Soviet and
Chinese models of neo-Stalinism placed heavy restrictions upon both producers
and consumers in Vietnam.French rule
was defeated in 1954, and by this time central authority had greatly weakened.
(Fforde and Vylder, 1996, p.56)The
Vietnamese were opposed to the Democratic Republic of Vietnam, which caused it
to be weak from the beginning.This
lack of support from the public played a large political role, but the shortcomings
of the DRV Model itself resulted in unfavorable outcomes for the economy.

THE DRV MODEL

In order to understand the DRV Model, some
recognition of the Socialist economy is required.(These criteria hold true for the Vietnamese economy of the time.)The Socialist central government was driven
by the goal of maximizing profit (Kornai, 1980, p. 339), which encouraged firms
to increase the volume of production.Producers had no control over the levels of production, as the laws of
supply and demand did not hold in the imperfect Socialist economy.The central government shaped a profit plan
determining output composition, which drove firms toward factor utilization.
(Kornai, 1980, p. 339)Profitability
was not an issue for individual firms, as the state covered any losses through
subsidies.

Industry operated under a soft budget constraint,
(Kornai, 1980, p. 306) which was shown in the following situations.The state controlled the prices of
goods.Observed prices did not reflect
the relative costs and benefits that control pricing decisions in a market
economy, a direct result of the chronic shortage. (Fforde and Vylder, 1996,
p.)That is,

prices and costs simply did
not matter to the firms.Firms were
given a variety of free grants to encourage production, which were realized as
increases in capital stock.Survival of
the firm did not depend on the firm’s ability to cover costs, which resulted in
profits being absorbed by the state. (Kornai, 1980, p. 309)Demand for the factors of production was
unlimited.

The DRV Model did not take
consumers’ preferences into account when determining the output goals.A forced substitution effect resulted, where
the chronic shortages forced consumers to opt for the available goods rather
than those desired. (Kornai, 1980, p. 332)The government had an insatiable demand for industrial inputs, believing
that complementary input supplies would not constrain output, because the
inputs would be continually imported.Foreign investment in modern industry became the most important element
behind economic growth, as it was the driving force behind output.The DRV Model was charged with the goal of
rapid development and setting production levels high.Food supplies were essential, but were not available domestically
because of the lack of attention to the deprived rural areas, a fundamental
flaw in the DRV Model.Costs increased,
domestic food supplies continued to decrease, and imports turned to consumption
goods rather than industrial complements. (Fforde and Paine, 1987, p.50)The rural areas had lower incomes, due to
the decrease in farm output, and as a result could not afford the high priced
food imports.Savings and investment
were decreasing, and the labor demanded by the manufacturing sector was not
available, as agricultural producers were looking to horizontal markets to find
incomes to feed their families.Agricultural production was not being transferred to industrial markets,
resulting in decreased output in this sector.The ineffectiveness of the government’s planning decisions, and the
failure to recognize these potential outcomes prevented economic growth.

Vietnam’s poverty was the main reason for foreign aid
being the driving force behind growth.The DRV had to import all modern means of production.(Tables 1 and 2)Through foreign aid, capital was increasing too fast for labor to
maintain market equilibrium, resulting in an initial increase in output, but only
in the short run.The increases in
capital required vast amounts of labor to achieve the output increases.

Jones and Samuelson’s Specific Factors Model
illustrates this point.Labor is a
mobile factor because it can be used in either the industrial sector or the
agricultural sector, while capital is a specific factor, because it is not
readily convertible into other forms.According to this model, a country with a lot of capital and limited
land will produce a high ratio of manufactured goods to agricultural goods.Through foreign investment, Vietnam became a
country with a lot of capital.Remembering that the central government encouraged firms to increase
production of manufactured goods, the demand curve for labor in the
manufacturing sector shifted to the right, causing more workers to be drawn
into the manufacturing sector and out of the food sector.(Graph 1)For the centrally planned economy of Vietnam, the labor demand function
was not effective, because there was no effective mechanism for the high demand
to create an incentive to attract labor, meaning the incentive for increased
output relied on the central planner to order labor to make the move.The government controlled the shifts in the
demand curve.

Manufacturing output
increased, as did the marginal product of labor, because there were more
workers in the sector with more capital to work with.Food output decreased, relative to the increase in manufactured
goods, because of the reduced labor input. (Table 3)The government assumed all industries had constant returns to
scale; that is, by increasing the capital stock, a proportionate rise in output
would arise (Fforde and Paine, 1987, p.38), thereby generating economic
growth.This was not the result, and
the assumption had devastating effects on the economy.

Labor, in a competitive market, will move to the industry
that offers the higher wage, as Ricardo suggested.Had Vietnam been a competitive economy, labor would have
willingly moved to the manufacturing industry.However, labor was forced to move through the plan, and the agricultural
sector was all but forgotten.Increased
output was realized at first, but as labor continued to move, the marginal
product of labor fell.(Graph 2)Theoretically, the wage rate will decline,
and labor will continue to move until the incentive to move is eliminated.In Vietnam, increased output of manufactured
goods was desired, but the government controlled wage rates, so equilibrium
between the two sectors was not reached.

One would suggest that Vietnam, like many less
developed countries, had many idle workers due to the abundant labor
supply.In 1960, the population of
working age residents was 749,700, while total employment in the economy was
614,500. (Fforde and Paine, 1987, p. 143-144)[2]The country had an excess capacity, so the
capital-intensive labor requirement should have been met.It was not attained for two reasons.First, only a small amount of capital was
invested in education, resulting in a labor force not adequately educated to
operate the capital-intensive industries efficiently, with the outcome of
diseconomies of scale. (Table 4)Second, the law of diminishing returns was evident with the
capital.Capital usage was increasing,
while labor basically remained fixed, so due to the capital/labor ratio, the
marginal product of capital was falling.Output was not increasing proportionate to added inputs.

The DRV Model was constantly dependent upon imports
and faced continuous difficulties in finding economic resources from the
domestic economy for its needs. (Fforde and Vylder, 1996, p. 67)The model was oriented towards urban and
modern industrial development, which resulted in this sector’s isolation from
the agricultural sector.The
ineffective central control, accompanied by a decrease in foreign aid at the
end of the war, led to decentralization of government agencies, (Fforde and
Vylder, 1996, p. 125) and the emergence of free markets.

THE SHIFT TO A MARKET ECONOMY

The end of the Vietnam War in 1975 saw the
integration of the Northern centrally planned economy and the Southern foreign
aid reliant economy.The North, because
of the DRV Model, had become isolated from the outside world, and as a
consequence was deficient in its economic development.North Vietnam did not possess such basic
institutional bases as an effectively functioning legal system or an adequate
statistical basis for economic planning. (Fforde and Vylder, 1996, p. 5)The DRV Model created a situation of low
agricultural involvement with heavy demands on the manufacturing sector, and
very little economic growth.An
alternative means for development needed to emerge.

The DRV Model established the prerequisites for
development.Capital deepening had
occurred, resulting in high rates of capital formation.(Graph 3)The major problem with development under the DRV Model was due to the
population shift out of agriculture and into the manufacturing sector. (Fforde
and Vylder, 1996, p.31)Market
mechanisms needed to emerge to correct the flaws brought on by the DRV Model.

State investment policies in Vietnam heavily favored
modern industry.To be successful in
development, the rural sector needed to be exploited and labor needed to be
marketed in the agriculture sector.The
DRV Model had shown that growth was not a result of capital accumulation,
bringing about a realization that autonomous activities, particularly the
development of markets and the agricultural sector, were essential for growth.

In the move to a market economy, agricultural
development was expected to play a key role.It would provide the raw materials and food to the urban sector, and
overcome the shortages experienced in the DRV Model. (Beresford, 1989, p.
134)This would stimulate the demand
for industrial products and assist in growth.Economic growth would be achieved through reforms in agricultural labor
productivity.Reforms were identified
through the introduction of collective agriculture and the utilization of the
division of labor.Marginal product of
labor increased because capital formations remained fixed while labor increased.Food was now being produced using very
little capital and a lot of labor.(Capital was introduced into the sector during the reforms with this
objective in mind.)The policy was now
in place to achieve economic growth through the agricultural sector supplying
the inputs to the industrial sector.

To achieve the desired productivity gains, a market
mechanism was needed to establish equilibrium levels in both industry and
agriculture.Equilibrium existed only
when transactions became voluntary, when economic agents had the freedom and
the ability to make pricing and allocation decisions. (Fforde and Vylder, 1996,
p. 35)Prices came to matter in the
transitional stage, as supply and demand began to determine production patterns
and utilization levels of the factors of production.The market mechanism brought continually increasing levels of
rural participation in the labor force.(Table 5)The labor force was
moving to areas with low capital-intensity, the agricultural sector.The state found it difficult to compete with
unplanned ways of acquiring and utilizing resources, and additional food
sources were hard to come by.Large-scale imports of food were necessary, (Beresford, 1989, p. 130)
causing a decrease in the balance of trade.The need to achieve self-sufficiency in food production became an
immediate concern.

In August of 1979, decentralization of economic
decision-making began following the Sixth Plenum, (Beresford, 1989, p. 204)
with the main focus on the promotion of agricultural production.The Sixth Plenum was the first viable
evidence of the breakdown of the DRV Model.Reforms were also introduced for autonomous planning by local industries
and direct trade between sectors.The
role of the state was now “to create conditions for economic establishments to
operate effectively.” (Beresford, 1989, p. 206)Business efficiency increases, as smaller consumer goods
industries were given priority over large-scale heavy industry.The initial stages of a market economy were
in place.

The government evaluated the agriculture sector to be
equivalent to the industrial sector, (Beresford, 1989, p. 137) where an
increasing one factor of production (labor) while decreasing the other
(capital) would result in sustained or increased output.This had previously failed in industry, and
the same outcome resulted in agriculture.Division of labor was supposed to achieve economies of scale, but the
government overlooked the nature of Vietnamese agriculture.Little specialization existed in agriculture
because of the crops produced, and the fact that the division was based on
traditional technologies where the division of labor was not feasible.New technology was being imposed on farms to
complement the divisions, and to harmonize the decreases in old capital, but it
was not practical because farmers did not have the training to use it
efficiently.The government’s plan was
once again ineffective.

The centrally planned economy was not motivating for
individuals to increase their economic activities, as there were no incentives
for people to increase their contributions to the economy.The motivation to work was to achieve
government set goals, which had rewards for the government at the end.The standard of living among the population
was low and workers were unhappy, resulting in low labor productivity. (Fforde
and Vylder, 1996, p. 44)The labor
force was concentrated in rural areas with low levels of income.In 1986, total income per month was
approximately 537 dong; total expenditure was 521 dong, with 80 per cent of
this being spent on food. (Fforde and Vylder, 1996, p. 119)The population recognized the
ineffectiveness of the government’s policies and demanded that changes be made.

During the DRV Model era,
consumption was compressed, resulting in a low standard of living.The market sector provided a link between
agriculture and industry, allowing for commodity exchanges to exist between the
two sectors. (Beresford, 1989, p. 177)Agriculture would provide wages, raw materials, and the exports
necessary to purchase capital goods.Industry would provide the manufacturing inputs and the capital
equipment necessary to increase the technological level of agriculture.
(Beresford, 1989, p. 179)(See
Edgeworth Box)Through these
transactions, the two sectors would support each other, incomes would escalate
in both sectors, consumption would increase, and the standard of living would
rise.The government’s allocation of
the factors of production was inefficient under the DRV Model, which is why trade
between the sectors was mutually beneficial and theoretically, trade would
result in an efficient allocation of the factors of production.High industrial development policies were
changed in favor of agricultural development, to alleviate high interest rates
and to stabilize investment in order to increase consumer goods output and
consumption. This change in capital formation and altering production in
response to consumers’ demands are two important components in the development
of Vietnam’s market economy. (Beresford, 1989, p. 188)

The state and collective sector were forced to
compete with the private sector as unplanned activities increased.Financial authority was decentralized and
competition to state industries emerged.The most important realization of competition was that firms previously
heavily subsidized by the state must now be allowed to go bankrupt. (Beresford,
1989, p. 207)Through this, efficient
allocation of capital and labor emerges.In a market economy, the firm will choose the lowest isocost line
tangent to the production isoquant when subjected to a minimizing cost
equation,

C = wL + rK.The firm also has to choose the highest
production isoquant tangent to a given isocost line, maximizing Y = F(K,L),
subject to the cost constraint wL + rK = C through these market mechanisms, a
learning curve resulted, when workers gained experience in tasks, resulting in
economies of scale as costs increases less proportionately with output.

The introduction of a market economy was Vietnam’s
first step to sustainable economic development.The transition was not flawless, nor would the following years
be.

ECONOMIC DEVELOPMENT

After 1989, the Vietnamese economy can best be
described as a market economy.The
two-price system had been abolished along with the system of central planning
based on state inputs and production targets.Vietnam had entered the ‘post-stage’ of development, (Fforde and Vylder,
1996, p. 40) where transactions were mainly voluntary, prices were established
according to supply and demand, and a rise in savings as a percentage of GDP
was witnessed.(Table 6 and Figure
1)

In 1990 – 1991, the state was still the dominant
owner of the means of production within industry, (Fforde and Vylder, 1996, p.
254) and as was the case with the DRV Model, resources were not efficiently
used.Soviet aid was lost after 1989,
causing a severe shock to the political economy.The macro economy was elastic, as prices stabilized with tight
monetary policy. (Fforde and Vylder, 1996, p. 282)The state sector was in shambles, as the economy destabilized
through interest rate distortions and tax breaks to state industry. (Fforde and
Paine, 1987, p. 131)Inflation
increases with the tax breaks, leading to a reassessment of the state sector’s
role in the market economy.Improvements in resource allocation were still possible because an
output surplus still existed, (Fforde and Vylder, 1996, p. 285) and could be
exploited, provided decentralization of state owned enterprises occurred and
the incentives structure improved.

Exploitation of rural economies needed to progress,
with emphasis on the application of the spillover effects from the Asian
Tigers.Asia’s growth was in response
to high saving, strong commitment to education and openness to trade. (The
Asian Miracle, 1997)Vietnam needed to
mold itself after these economies.

Economic growth models have been developed in
attempts to explain why some economies grow faster than others.The Romer model of economic growth demonstrates
the flaws Vietnam has in its route to development

THE ROMER MODEL

Capital is accumulated according to the equation k =
sy – (n+d) K, where sy is gross investment, dK is the depreciation in capital,
and nK is the population growth of capital per person.As graph 3 shows, capital was accumulated
during the DRV Model, but as it accumulated, it also depreciated.The capital saved demonstrates diminishing
returns; the future marginal product of capital is less than its present
value.Vietnam had experienced capital
deepening resulting in increases in the capital stock.(Graph 6)The simple Solow model explains that countries with high investment
rates will have higher output per worker, provided the population growth is
low.Through foreign aid, Vietnam’s
investment levels continued to be high, but population growth was also
high.Due to this, a balanced growth
path could not be reached; output, population growth, and capital accumulation
would not be equal.

Economic growth was to be achieved exogenously.Rather than heavily funding research
sectors, technology was imported.This
was beneficial, as output increased in the early 1990’s, and the cost was
minimal.(Table 7)However, exogenous growth resulted in
temporary growth rates, as there were no long run growth effects.The increase in investment had a long run
effect on the level of output per
worker, but did not affect the long run growth
rate per worker.(Graph 7)At the time of the policy change, output per
worker increased rapidly, which continued until the output-technology ratio
reached its new steady state, where growth returned to its long run level.(Graph 8 and Table 7)For these reasons, the only plausible way of
increasing economic growth was through worker education.

A country can achieve long run economic growth by
investing in human capital.Human
capital is accumulated as individuals devote time to learning new skills rather
than working.The economy recognizes
the availability of the educated labor, and exploits it according to the
production function Y = K (AH), where Y is total output, A is the amount of
available technology, and H is the amount of skilled labor accessible.Labor accumulates education according to L =
(1 – u) P, where u is the fraction of time an individual spends learning the
skill, L is the total amount of unskilled labor, and P is the population of the
economy.Thus, L is equivalent to H in
the production function, proving that if Vietnam had invested more capital and
time into educating the workforce output would have increased, because labor
would have been able to the technology more efficiently, allowing total factor
productivity to increase, and converge with the economies of the Asian
Tigers.Vietnam was engrossed with
neo-Stalinist ideals, resulting in a shortage of workers possessing skills
suited to the developing economy.

Vietnam’s current population is approximately 77.3
million, with a growth rate of 1.37 per cent. (The U.S. State Department,
1999)The high population growth rate,
according to the neoclassical model, is detrimental to the economy, because
more capital is required to keep the capital-labor ration constant.Investment needed to increase to keep this
ratio constant.For the 1996 – 2000
period, Vietnam’s government set a goal of $42 billion in investment, to
maintain growth rates of 9 – 10 per cent, (The U.S. State Department, 1999)
with $21 billion coming from domestic sources.To achieve these goals, Vietnam will have to boost domestic savings,
which will be difficult because of the underdeveloped financial system and
because of the low faith in local banks.High population growth, along with the disappearance of the DRV Model’s
allocation of labor to state owned enterprises, led to high levels of
unemployment, at approximately 25 per cent in 1995. (The World Factbook,
1999)With unemployment high, these
investment levels may be unrealistic.To attract capital and investment in Vietnamese business, focus is
needed on the institutional aspects of the economy, mainly on better markets
and better education.

RECOMMENDATIONS

The economy of Vietnam has a great deal of unused
potential for economic development.The
decision to decentralize state owned enterprises was a good one, yet it has not
been fully implemented.Since 1993,
only 29 of 5800 state owned enterprises have been partially sold off. (The Ho
Chi Min Trial, 1998)Privatization of
these enterprises would result in greater profits for the private sector, as
the state monopoly would weaken, and competition would increase.The incentive to be creative and innovative
would arise.Vietnam also needs to open
up its economic markets.A stronger
statistical base is needed for the growing markets.Knowledge is required to supply the growing markets with demanded
information.The rural economy needs to
be given more priority, as it is the supplier for the inputs of growth.An emphasis on internal strengths needs to
be taken, and foreign aid must be used efficiently.The Vietnamese have to accept the market economy as a parallel to
the centrally planned economy, and allow the market forces to take their
course.

REFERENCES

Beresford, Melanie. (1998). National Unification and Economic
Development inVietnam. New York: St. Martin’s Press.